Fed to be tougher cop on the beat, Bernanke says

Defends bank stress tests as 'rigorous'

WASHINGTON (MarketWatch) - A period of introspection as a result of the banking crisis has led the Federal Reserve to conclude that it will have to be tougher on bank management in the future, Federal Reserve Board Chairman Ben Bernanke said Thursday.

Over the past two years, U.S. banks have found themselves desperately short of capital after their risky investments backed by poorly-underwritten mortgage loans blew up. Taxpayers have had to step in with over $700 billion in bailout funds.

And results of bank stress tests, to be disclosed later Thursday, will show that banks still need more money.

Some analysts have argued that regulators stress test did not include much stress. But Bernanke defended them - saying the exercise has been "comprehensive, rigorous, forward-looking, and highly collaborative."

Bernanke and Treasury Secretary Timothy Geithner are expected to release the final results of the stress tests at 5:00 pm Eastern. The results have been trickling in for the last few days.

Bernanke's speech, made via satellite to an annual bank conference sponsored by the Chicago Federal Reserve bank, was remarkable in the sense that he admitted the crisis has led to soul-searching at the central bank and a new-found commitment to get tough on bank management in the future.

"The crisis has...underscored the need for heightened vigilance and forcefulness on the part of supervisors to make sure that standards are met," he said.

Bernanke suggested that, in the past, Fed supervisor warnings were ignored by bank management or hidden from the bank's board of directors.

"We must ensure that our supervisory communications are forceful, clear, and directed at senior management and boards of directors, so that emerging issues are given proper attention and satisfactorily resolved," he said.

Hold on to powers

But an important sub-text of Bernanke's remarks was that the Fed wants to hold on to the massive bank supervisory powers that it won over the past thirty years.

Some central banks around the world are getting out of the supervisory business and focusing strictly on monetary policy, but Bernanke made the argument that having the two powers under one roof enhanced both policies.

On the one hand, knowledge of economic developments was useful in ferreting out information from banks. At the same time, the health of banks was central to monetary policy.

Bernanke also said that the Fed needed some better power to oversee "all parts" of bank holding companies.

Washington also needs new powers to go where needed to uncover "risks to the financial system as a whole," he said.

Bernanke stopped short of saying that the Fed should have these powers but many members of Congress believe it is a natural fit for the central bank.

Something's got to give

Charles Calomiris, an expert on the Fed and regulation at Columbia University's Business School, said he hopes that the Fed is given authority to oversee the entire market for systemic risk.

But Calomiris said the Fed should give up many powers, including day-to-day supervision of banks and other more political responsibilities like merger approval.

"Other developed countries have wisely moved to insulate their central banks from regulatory policies like these, which politicize the central bank and make its monetary mission more difficult, and which also undermine the credibility of regulatory interventions by the central bank, when needed," Calomiris wrote in an email from Asia where he is traveling.

"Whether President Obama decides to reorganize regulation to reduce politicization or to expand it will be a litmus test of whether he is truly interested in reform, and also of whether he is able to resist [House Financial Services committee chairman] Barney Frank, who advocates placing powers in the Fed largely because he knows he can exert influence over it," Calomiris wrote.

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